iPhone-as-a-service? Enter the period of everything-as-a-service

Wed 06 Nov 2019

Charles Darwin gave us the theory of evolution. The species most adept to change survives. This model applies not just to organisms but to economies and businesses. In fact, so ubiquitous is the analogy between business and hunting and survival dynamics the language we use to describe ordinary business processes and transactions often stem from this field; “Head hunters” connect employees and new job roles and salesman “eat what they kill”. Now, we are observing a change in the current business offering zeitgeist; the explosion of service or subscription business models, which often bring with them a recurring revenue stream, at the expense of traditional business models. The companies most likely to thrive are those who can capitalise on this trend by pairing a service or subscription offering with their primary product or service.

In their most recent earnings release Apple demonstrate how important the services they offer, to name a few, Apple Music, Apple Pay and Apple TV are to not just their current profit numbers, but the long term growth of their top line. In fact, services revenue hit an all-time high of $12.5B this quarter. However, the most interesting takeaway is how Apple are starting to signal to investors that they may sell their iPhone on a subscription basis. “We’re cognizant that there are lots of users out there that want a sort of a recurring payment like that” said CEO Tim Cook. While technically feasible, we will have to wait and see how the strategy develops and how consumers react.

And Apple is not alone. Netflix and Spotify are two businesses that clearly operate under the recurring revenue model, and have attracted premium valuations as result. Apple on the other hand, often trades at lower multiple than other technology companies or the FAANG stocks and is often included in “Value factor” strategies as result. Is this just an attempt to raise the multiple investors are willing to pay by the Apple board? Or is it a value generative long term play that will prove to the world the company is not just a smartphone one-trick pony about to enter managed decline? Buy-side analysts and fund managers will have to make a judgement call, however we note that Warren Buffet believes the latter.

To conclude, we must keep in mind that not all business offerings can function under a subscription or service model, despite what management signal at their earnings conferences. Domino’s Pizza once said they are a technology company that just happen to make pizza, however they just use apps and tracking systems to improve their service. Calling a company a technology company does not make it so. As far as we are concerned, if you do not sell software, hardware or semiconductors, you probably are not a technology company. Investors must look past the marketing material released by the CEO, and analyse the actual economic reality and sustainability of the business model. Services and subscription models are on the rise, as well as companies trying to associate themselves with the technology sector, but equity fund managers must see through the noise and not pay for these companies at any valuation.